Why the Canadian Dollar Is Hot

Like most risk-sensitive currencies, the Canadian dollar is having a good day. And the good times are likely to last, says Camilla Sutton, chief currency strategist at Scotiabank.

The reason, she says, is the Bank of Canada.

The Canadian dollar weakened slightly in the fourth quarter of 2012, but that was largely due to investors' early uncertainty about the direction of central bank policy, Sutton says. Once it became clear that the Bank of Canada was not going all dovish, the loonie recovered - and set the stage for 2013.

"CAD's performance in Q4 underscores our bias for strength into year end 2013, given that relative monetary policy will continue to provide support to CAD relative to the USD," Sutton wrote in a note to clients. She expects the Federal Reserve to remain extremely accommodative, which will weigh on the U.S. dollar relative to the loonie.

Then there are the fundamental factors. "While Canada's domestic outlook has dampened somewhat, the ongoing support from diversification flows underpinned by relatively strong fiscal metrics will help maintain CAD strength," Sutton says. The country's credit rating doesn't hurt either. "Canada shines on a relative basis in terms of central bank policy and sovereign risk."

Altogether, Sutton expects the U.S. dollar to finish the year at 0.9600 relative to its northern neighbor.